Hoisington Quarterly
Review and Outlook, Second Quarter 2017

I have often written about the
Fed’s abysmal track record in managing the economy. In today’s Outside the Box, Lacy Hunt
and Van Hoisington of Hoisington Investment Management give us an in-depth
tutorial on the reasons for the Fed’s consistently poor record.

They start by considering the Fed’s
“dual mandate,” which sets “the goals of maximum employment, stable prices and
moderate long-term interest rates.” (And yes, that is actually three goals, not
two.) But a problem arises, the authors note, “because considerable time
elapses between the implementation of the monetary actions designed to follow
the mandate and when the impact of those actions take effect on broader
business conditions.” The time lag can easily be three years or longer, with
the result that policy changes often end up being pro- rather than
countercyclical. To make matters even worse, “the economic risks from adherence
to this dual mandate are now much greater than historically due to the
economy’s extreme over-indebtedness, poor demographics and a fragile global
economy.”

In the real world, the dual mandate
can break down. Now, the Fed is tightening over concerns about wage pressure
from a low level of unemployment, yet inflation has run consistently below the
Fed’s 2% target for the past year or more. Enter the Phillips curve.

The Phillips curve represents the
relationship between the rate of wage inflation and the unemployment rate.
Proponents of the curve see an inverse relationship between the two, but that,
say Lacy and Van, is a simplistic conclusion. Under both Bernanke and Yellen,
the Fed has come to rely greatly on the Phillips curve – in spite of the fact
that both Volcker and Greenspan panned it. Alan Meltzer, whose multi-volume
series A History of the
Federal Reserve is widely considered to be the definitive study of
the Fed’s operations, said “The Fed’s error was to rely on less reliable models
like the Phillips Curve ... that ignore or severely limit the role of money,
credit, and relative prices.” Meltzer adds, “Year after year, growth and
employment are below forecast. One might hope that repeated forecast errors all
in the same direction would raise doubts about the usefulness of the model or
models and initiate search for a better model. This does not appear to have
happened.”

Over the past few weeks I have
identified a Fed policy error as one of the major potential triggers for the
next recession/bear market. In my conversations with Lacy we talk a lot about
the (oft-realized!) potential for Fed policy mistakes – and I am sure it will
be a hot topic again this year at the annual economics, fishing, and tippling
fest in Maine, coming up in just a few weeks. I simply do not get this fetish
for “quantitative tightening.”

Shane and I will be on yet another
plane tomorrow and then back late Sunday night. Then, after a few days of
meetings, I will begin to make my way to Maine via Philadelphia, where I will
pick up fishing partner Steve Blumenthal of CMG. There are so many old friends
at “Camp Kotok” – I have shared the experience with them for over a decade now.
I normally go with my son Trey, but he can’t get off work, which is responsible
of him but disappointing. Have a great week!

Your wondering how the Fed can keep
using the same models that clearly don’t work analyst,

John Mauldin, Editor
Outside the Box

Hoisington Quarterly
Review and Outlook, Second Quarter 2017

By Dr. Lacy Hunt and Van
Hoisington

The Fed’s Dual Mandate

“Dual mandate” is one of the most
commonly used phrases in U.S. central banking. The current Chair of the Federal
Reserve often mentions it in both speeches and testimony to Congress. Not
surprisingly, this is an extremely hot topic in monetary economics, and
execution of this mandate has profound significance.

The mandate originated in The
Federal Reserve Reform Act of 1977. This legislation identified “the goals of
maximum employment, stable prices and moderate long-term interest rates.”
Ironically, these goals have come to be known as the Fed’s “dual mandate”, even
though there are actually three goals. The manner in which the Fed operates in
following these goals has had and will have dramatic effects on economic
activity. In this report we consider:

What is the causal link between
the mandate and the Fed’s capacity to act in a counter-cyclical fashion?

How has the dual mandate
morphed into the Phillips Curve?

What are the arguments for and
against a Phillips Curve based approach for conducting monetary policy?

What does empirical research
reveal?

In view of the extreme
over-indebtedness and other adverse initial conditions, what are the immediate
consequences of using a Phillips Curve based dual mandate for the economy, the
Fed and fixed income investors?

Causality

To achieve the goals of this
mandate (maximum employment, stable prices and moderate long-term rates), the
Fed will inevitably tighten for too long and by too much. This occurs because
considerable time elapses between the implementation of the monetary actions
designed to follow the mandate and when the impact of those actions take effect
on broader business conditions. By waiting to recognize a definitive change in
inflation and unemployment, monetary policy changes will be pro-, not
counter-cyclical. The time difference between leading or causative measures
like the money and reserve aggregates, on the one hand, and the economically
lagging series of the unemployment rate and inflation, on the other hand, can
easily be three years or longer.

This difference between the actions
of the Fed and the reactions within the economy explains why the Fed
historically has not begun easing cycles until the economy was either in, or on
the cusp of, a recession. When the Fed takes action, relief is painfully slow
in arriving. Importantly, the economic risks from adherence to this dual
mandate are now much greater than historically due to the economy’s extreme
over-indebtedness, poor demographics and a fragile global economy.

To demonstrate, suppose that in the
fourth quarter of this year, unemployment turns significantly higher while the
inflation rate decelerates from its already subdued pace. The downturn that the
Fed would be witnessing in the fourth quarter could be reflecting policy
actions all the way back to the fourth quarter of 2015 when they initiated the
current tightening cycle. This cumulative evidence is reflected in the monetary
and credit aggregates (Charts 1 and 2). This change in economic fortunes might
cause the Fed to accelerate the rate of growth in the monetary base and lower
the policy rate in order to stimulate money and credit growth. However, the
monetary and credit aggregates might not respond to these first steps until
2019 or even 2020, thus putting the Fed three years or more out of sync with
the needs of the economy, suggesting a prolonged period of severe
underperformance.

Being out of step with the goals of
a counter-cyclical monetary policy will arise as long as the Fed keys its
decision-making on unemployment and inflation, rather than on maintaining
financial stability, which focuses on the reserve, monetary and credit
aggregates. Achieving such stability, however, is now much more difficult for
the Fed than in the past. Until the economy became so heavily indebted, M2 was
a consistent leading economic variable. Now M2 only leads recessions. Until the
debt overhang is corrected (which does not appear to be in the immediate
future), the velocity of money is likely to continue declining. Thus, when the
Fed eases in the future, the strong leading relationship between M2 and the
economy will no longer prevail.

There have always been lags between
the time of a policy shift and evidence of that shift in the broader economy.
However, in a heavily indebted economy, with the velocity of money likely
falling further, and policy rates close to the zero bound, the Fed’s current
capabilities are decidedly asymmetric. Any easing actions taken now would be
far less powerful than the steps taken in the prior tightening cycle. Thus, by
keying off the dual mandate in an economy with a severe debt overhang, the Fed
would be more disadvantaged than normal in trying to come to the quick aid of a
faltering economy.

From the Dual Mandate to
the Phillips Curve

The Federal Reserve Reform Act of
1977 does not spell out the nature of the trade-off between the unemployment
rate and the inflation rate, nor does it say how the Fed should act if the
mandates are at odds in terms of the policy approach.

The potential problems that arise
from this lack of clarity are clearly illustrated by the current situation. The
Fed has extended the current tightening cycle twice this year, with the latest
move on June 14. At the time of the latest decision, headline and core CPI had
year-to-date price increases of 1% and 1.3%, respectively, substantially below
their 2% target. Additionally, the latest twelve-month increases in both of
these inflation gauges were below the 2% target. Only the unemployment rate
warranted more restraint. This means that inflation and unemployment are at
odds, thus the dual mandate is dead. It now boils down to the Fed’s
interpretation of the Phillips Curve.

The most definitive study of the
Fed’s operations is widely considered to be the multi-volume series, A History of the Federal Reserve written
by the late Carnegie Mellon economist Alan Meltzer (1928-2017). Volume I examines the span
from the creation of the Fed in 1913 until the accord with the Treasury in 1951.
Volume II, Book 1 covers
the years from the accord in 1951 until 1969, while Volume II, Book 2 discusses the period from
1970 until the end of the great inflation period in the mid-1980s. In this
scholarly historical examination, Meltzer, on the basis of price and financial
stability, gave the Fed high marks in only one-fourth of its years of
operation. Meltzer made many seminal contributions to economics, including
identifying the algebraic determinants of the money multiplier and outlining
the transmission of monetary policy actions to the real economy.

In his 2014 paper, “Recent Major
Fed Errors and Better Alternatives,” Meltzer summarized the root cause of the
Fed’s policy errors and long record of failed forecasts as follows: “The Fed’s
error was to rely on less reliable models like the Phillips Curve ... that
ignore or severely limit the role of money, credit, and relative prices.” By
focusing on the Phillips Curve, Meltzer contends that the Federal Open Market
Committee (FOMC) overemphasizes information in monthly and quarterly data
periods while giving insufficient attention to persistent trends in money and
credit, which are the very aggregates that the Fed supplies. To paraphrase
Meltzer, by relying on the Phillips Curve, the FOMC avoids developing a
strategic view of their role and the complex world in which they operate. As
the massive credit buildup leading up to 2007 illustrates, the Phillips Curve
mandate also diverts the Fed’s attention from important regulatory matters that
can have extremely consequential and long lasting macro implications.

The key passage that Meltzer writes
to describe the inadequacies of the Phillips Curve/ dual mandate within the Fed
is as follows:

No less an
authority than Paul Volcker explained publicly and to the staff that the
Phillips Curve was unreliable and not useful. As Chair, he gave many talks
about what I have called the anti-Phillips Curve. Volcker claimed repeatedly
that the best way to reduce unemployment was to reduce expected inflation. He
did not use Phillips Curve forecasts. He ran a very successful policy. Alan
Greenspan was less outspoken, but he also rejected Phillips Curve forecasts as
unreliable. Instead of finding a better model, the staff resumed use of
Phillips Curve forecasts. They were again unreliable as should be evident from
the repeated prediction errors ... Year after year, growth and employment are
below forecast. One might hope that repeated forecast errors all in the same
direction would raise doubts about the usefulness of the model or models and
initiate search for a better model. This does not appear to have happened.

In the three years since this
prophetic passage, the string of unbroken economic forecasts continued
unabated.

The Phillips Curve

The Phillips Curve represents the
relationship between the rate of wage inflation and the unemployment rate. In a
1958 study, New Zealand economist A. W. H. (Bill) Phillips (1914-1975) found an
inverse relationship between wage inflation and the unemployment rate in the
United Kingdom from 1861 to 1957. A high unemployment rate correlated with
slowly increasing wages, while a lower unemployment rate correlated with
rapidly rising wages.

According to Phillips, the
reasoning for this finding was that the lower the unemployment rate, the
tighter the labor market, thus firms would raise wages to attract scarce
workers. Conversely, at higher rates of unemployment the pressure on wages
abated. Thus, this curve attempts to capture a cyclical process that can be
used for evaluating the business cycle. This curve presumes the average
relationship between wage demands and the unemployment rate is stable, thus
there is a rate of wage inflation that results if a particular level of
unemployment persists over time. As time has passed, Phillips Curve proponents
have also asserted that a stable relationship exists between the unemployment
rate and the overall rate of inflation, not just that for wages. The original
Phillips Curve shows a downward sloping line on a graph, with wage inflation on
the vertical axis and the unemployment rate on the horizontal axis.

In a 1967 peer-reviewed paper,
Edmund Phelps challenged the theoretical structure of the Philips Curve.
Independently of Phelps, Milton Friedman (1912-2006) in his Presidential
address to the American Economic Association in 1967 (published in 1968) came
to similar conclusions. They reasoned that well-informed rational employers and
workers would pay attention only to real wages (i.e. the inflation adjusted
level of wages). In the view of Friedman and Phelps, real wages would adjust to
make the supply of labor equal to the demand for labor, and the unemployment
rate would then stand at a level uniquely associated with the real wage rate.
In time this uniquely associated real wage rate has come to be called the
“natural rate of unemployment.”

Friedman and Phelps argued that the
government could not permanently trade higher inflation for lower unemployment.
When the natural rate of unemployment prevails, the real wage is constant.
Workers who expect a given rate of inflation insist that wages increase at the
same rate to prevent the erosion of their purchasing power.

Consistent with Friedman and
Phelps, consider the effects of a monetary policy designed to expand economic
activity in an attempt to lower the unemployment rate below its natural rate.
The resulting increase in demand (pricing power) encourages firms to raise
prices faster than workers anticipate. With higher revenues, firms are willing
to employ more workers at the old wage rates and in some cases are willing to
somewhat boost them. With rising wages, workers willingly supply more labor,
which leads to a drop in the unemployment rate. Initially, they do not realize
that their purchasing power has eroded since prices have advanced more rapidly
than expected. In this initial period workers suffer from what is known as a
“money illusion” – the rise in nominal wages is not equal to the rise in real
wages. As workers come to anticipate higher rates of price inflation over time,
they see through the money illusion, and less labor is supplied and demanded.
The real wage is restored to its old level, and the unemployment rate returns
to its natural rate. Today, the opposite case is present. Monetary restraint is
limiting demand and eroding pricing power, causing employers to restrain wages.
Once workers realize this restraint is not a cut in real wages, they will
continue to supply the same amount of labor. The Phillips Curve trade-off does
not exist in either of the two alternative situations.

Phelps and Friedman also
distinguish between these effects over the “short run” and the “long run”.
Phillips Curves only prevail so long as the average rate of wage inflation
remains fairly constant. Only in such a limited time frame will wage inflation
and unemployment be significantly inversely related. Once the higher inflation
is fully incorporated into expectations, unemployment returns to the natural
rate, with the result that the natural rate of unemployment is compatible with
any rate of inflation. These long and short run relationships can be combined
in an “expectations augmented” Phillips Curve. The quicker workers adjust price
expectations to changes in the actual rate of inflation, the quicker the
unemployment rate will return to the natural rate and the less successful the
government will be in reducing unemployment through monetary and fiscal
policies. The expectations augmented Phillips Curve approach is used in and
appears to play a major role in the Federal Reserve’s large-scale econometric
model.

Empirical Evidence

We examined the relationship
between percent changes in real average hourly earnings and the unemployment
rate from 1965 through 2016 – the entire historical record for wages. This
sample is comprised of over 600 monthly observations (Chart 3). The trendline
fitted through the observations does have a slightly negative tilt, but the
line is not statistically different from a straight horizontal line, which
signifies a total lack of responsiveness of real wage changes to the
unemployment rate. The adjusted R2 is 0.04, which is not statistically
significant. Thus, our empirical findings are consistent with the causality
outlined – that the Phillips Curve assumption is not valid. Cherry picking
through the data points can identify limited time periods when a greater
inverse relationship exists between wage increases and the unemployment rate.
As many researchers have pointed out this was true of the 1960s. From the first
half to the second half of the 1960s, nonfarm business sector compensation per
hour (a widely followed measure of labor compensation) increased from 3.6% per
annum to 5.9% as the unemployment rate fell from 5.7% to 3.8%. The critical
point is that these individual episodes of an apparent Phillips Curve trade-off
are too weak and too infrequent to establish an enduring relationship over
time.

The adherents to the Phillips Curve
do not accept these various empirical criticisms. For many decades, they insist
that the poor results are due to the fact that the basic relationship has not
been properly quantified. They point to the problems capturing leads and lags
between the unemployment rate and wage changes as well as difficulties that arise
from measuring expectations and working with aggregate data. For followers of
the Phillips Curve, it is just a matter of time before these issues of
statistical quantification are resolved.

These arguments are not compelling,
yet they have been used repeatedly for at least a half a century. As the years
have passed, the constantly restated Phillips Curve formulations have regularly
missed major business cycle developments, a pattern which has been evident in
the Fed’s record. The Fed presided over the worst U.S. peacetime inflation from
1977 to 1981, and tightened before all of the recessions after 1977. The Fed
did contain the Panic of 2008 with excellent lender of last resort tools, but a
far better result might have been achieved if the Fed had learned the lesson of
the 1920s and prevented the massive buildup of debt prior to 2008 that the
regulatory powers of the Fed were designed to prevent.

For most of the past eight years,
the frequently restated Phillips Curve models have pointed to a sustained acceleration
in wage and price inflation that has failed to materialize. These failures not
only impair monetary policy but also portfolio decisions based on the presumed
efficacy of the Phillips Curve and the reliability of the dual mandate. Based
on the slowdown in the monetary and credit aggregates, and the continuing fall
in the velocity of money, the rate of inflation is more likely to moderate
rather than accelerate, even as the unemployment rate in May 2017 stood at a
sixteen year low. Thus, inflation, on average, moved lower during this current
expansion, contradicting the forecasts for higher inflation based on the
Phillips Curve concept. the velocity of money, the rate of inflation is more
likely to moderate rather than accelerate, even as the unemployment rate in May
2017 stood at a sixteen year low. Thus, inflation, on average, moved lower
during this current expansion, contradicting the forecasts for higher inflation
based on the Phillips Curve concept.

Implications

For the Fed, the more advisable approach
would be to pull the Phillips Curve relationships from their model and their
policy decisions. Instead, they should rely on capturing the strategic role of
the monetary transmission mechanism and its potentiality for moving through the
reserve, monetary and credit aggregates in a highly leveraged economy. If the
Phillips Curve proponents are right, and the quantification efforts are
eventually proved to be valid, then at that point they can be inserted into the
Fed’s model as well as into their subjective decision-making process.

This is relevant to investors as
well. If adherence to the dual mandate induces financial insatiability, then
investor performance, like overall economic activity, will be directly
influenced. If the Fed’s mandate consistently leads them in the wrong
direction, then long-term investors may often be forced to construct portfolios
that are contradictory to the error-prone words, forecasts and policy actions
of the FOMC. Moreover, investors should expect that the Fed’s actions will
create substantially more volatility in the financial markets and particularly
so over the short-term. Operating with strategic views and multi-year trends,
rather than trying to focus on the Fed-generated noise in many monthly and
quarterly indicators, may be a preferred method of generating investor returns.

Our economic view for 2017 is
unchanged and continues to suggest that long-term Treasury bond yields will
work irregularly lower. The latest trends in the reserve, monetary and credit
aggregates along with the velocity of money point to 2% nominal GDP growth for
the full year, down from 3% in 2016. This would be the third consecutive year
of decelerating nominal GDP growth and the lowest since the Great Recession.
This suggests that the secular low in bond yields remains well in the future.

THIRTY-ONE years ago, The Economist created the Big Mac index as a way of gauging how different currencies stacked up against the dollar. The index is based on the theory of purchasing-power parity, the idea that in the long run, exchange rates should adjust so that the price of an identical basket of tradable goods is the same. Our basket contains one item, a Big Mac.The latest version of the index shows, for example, that a Big Mac costs $5.30 in America, but just ¥380 ($3.36) in Japan. The Japanese yen is thus, by our meaty logic, 37% undervalued against the dollar..In that, the yen is not alone. The greenback has strengthened considerably in recent years: of the 34 currencies we track in the full index, 31 are currently undervalued against the dollar. Only the Swiss franc, Norwegian krone and Swedish krona are overvalued. That said, plenty of currencies have clawed back some ground against the dollar in the past six months.

Take, for example, the Egyptian pound, which burgernomics holds to be the most undervalued currency. In November, the Egyptian government decided to allow its currency to float freely. By December the pound had fallen to its current value of around 18 per dollar. Inflation has soared as a consequence, averaging 30% over the past six months. Big Mac prices have increased accordingly, from 27.5 pounds ($1.53) to 31.4. The net result, according to our index, is that the Egyptian pound has gone from 71% undervalued against the dollar in January to 67% today.

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The euro has also gained ground in the same period. The single currency buys $1.14 today, up from $1.05 at the start of the year; the euro has gone from being 20% undervalued against the dollar in our index, to 16% undercooked. That reflects a mixture of politics and economics. Eurosceptic parties were beaten back at the polls in both the Netherlands and France, muting fears that populists would find success. The euro zone grew substantially faster than the American economy in the first quarter, and the European Central Bank has started to signal that its policy of extraordinary monetary stimulus will not last for ever. If Europe’s recovery continues to strengthen, American tourists to the continent may end up getting less burger for their buck.One of the best-performing currencies over the past six months has been the Mexican peso. In January, the peso had fallen to a record low of 22 to the dollar, thanks in no small part to fears of a possible trade war with Mexico’s northern neighbour. But markets have become increasingly sceptical that Donald Trump will follow through on his most blood-curdling trade threats. The peso has recovered ground and hovers at around 18 per dollar. The Mexican currency is now only 48% undervalued against the greenback, compared with 56% in January.Markets are also losing faith in Mr Trump’s ability to pass domestic economic reforms. On the campaign trail, the president-to-be promised expansionary fiscal policies, including tax cuts and increased infrastructure spending. Traders believed that the Federal Reserve would be forced to increase interest rates in response. The dollar surged, reaching a 15-year high in January. Since then, the dollar has slipped by 5% on a trade-weighted basis. That not only vindicates those sceptical of Mr Trump’s legislative prowess. It’s also a partial vindication for believers in burgernomics. If our index has any fact content, the dollar may have further to fall.

One of the kookiest moments last month came when Fed Chairwoman Yellen spoke about seeing no financial collapse in sight during our lifetimes

“Would I say there will never ever be another financial crisis? No. Probably that would be going a little too far, but I do think that we’re much safer, and I hope that it will not be in our lifetimes, and I don’t believe it will be.” (CNBC Play video for quote on next crisis.)

That certainly calls to mind the times when Chairman Ben Break-the-banky pontificated about there being no housing bubble and no recession in sight:

Yellen’s predecessor, Ben Bernanke, once famously called problems in the subprime mortgage market “contained,” a statement that would be proven wrong when the collapse of illiquid mortgage-backed securities cascaded through Wall Street and contributed to the worst economic downturn since the Great Depression.

Asked at a recent FOMC meeting about any possible problem with banks still being too big to fail, Yellen only said, “I’m not aware of anything concrete to react to.”Nice to know she’s sound asleep while sugar plums dance in her head, bringing forth prophecies of good times for the rest of everyone’s foreseeable life … or, at least, the rest of hers.When a Fed chair says something as audacious as there is no chance of another financial crisis in our lifetimes and when she sees no concrete situations of banks being too big to fail, even when the ones that were too big to fail last time are now twice as big, I think Titanic disaster. I think of all those nuclear experts who said, when three Fukushima reactors were blowing up and melting down, that they saw no chance of meltdown anywhere because these reactors were built too tough to melt down. As they spoke, you could hear the reactors exploding and see tops blowing off the buildings on videos playing behind them and watch people running around in protective suits, which made for quite a spectacular orchestration of expert feel-safe baloney.“Nothing to see here, folks. Just minor gas venting, typical of reactors in a non-meltdown stage of something. Move along.”I think minor gas venting is what we are hearing out of Yellen.The inability of central bankers to see anything coming, even as it is bearing down on top of them, is classic. If recessions were trains, Yellen would be tied to the tracks right now, sipping tea. Her saucer would be rattling on the rails, but you wouldn’t be able to hear the rattle because of the rumbling of a locomotive in the background. Yellen would look up from her tea cup and smile at you like the nice grandmother that she is as the train runs over her.You can also comfort yourself with this bit of superior Fed protection: All of Yellen’s major underling banks just passed the Fed’s most stringent stress test of their reserves. Because they passed gloriously, Yellen & Co told them they can now reduce their reserves, just as she is talking about strapping the economy with quantitative tightening. This move is for the important reason of freeing up something like $100 billion so they can pay themselves fat bonuses and share the wealth with their stockholders.Whew! Glad the risk of being too big to fail is over. Maybe she meant she has just removed the risk for banksters and major share holders because they all get their bonuses now before the banking collapse.If you wonder how blind Grandma Yellen is, look at her following statement, which offers a penetrating glance into the obvious:

Valuation pressures across a range of assets and several indicators of investor risk appetite have increased further since mid-February… (Zero Hedge)

Really? Just since mid-February? That was the first time you noticed that maybe, just maybe, the stock and bond markets were starting to look a little bubbly? These high valuations are just nowpressuring the Fed to back off on stimulus because the market started to look a tad inflated in February?She made this statement in order to justify her other statement ab out the Fed’s following choice to reduce stimulus even though it’s inflation target has not yet been met:

The Committee currently expects to begin implementing the balance sheet normalization program this year provided that the economy evolves broadly as anticipated…

So, the Fed has changed its metric from its mandate of manipulating inflation to setting policy based on curbing overly exuberant market valuations. Once again, we see evidence that the Fed is manipulating markets and setting a course correction on stimulus because of markets.In other words, the Fed wants you to believe the bubblicious pricing of stocks was not something they rigged by “trying to create a wealth effect” in “front-running the stock market” as former Fed governor Richard Fisher said of the actions he was involved in, but that it is just a side-effect of their stimulus that now pressures them to back down. No, it was dangerous manipulation that is now pressuring the Fed to pursue a course of unwinding stimulus.

The Great Unwind is about to beginThe unwinding of the Federal Reserve’s balance sheet has been saved to the end because it is more problematic than either the end of quantitative wheezing or the end of low-interest policy, and it is being carried out be people who have never seen a recession coming in the past and who see no reason to believe we will ever again in our lifetimes see a financial crisis like the last one.By “the Great Unwind,” I mean the reversal of QE (quantitative tightening). While investors are buoyed a little by Yellen’s dovish indication this week that the Fed will only raise interest one more time, the reversal of QE over time will be by far the Fed’s most difficult change toward normalization to navigate.

JPMorgan Chase & Co. Chairman Jamie Dimon said the unwinding of central bank bond-buying programs is an unprecedented challenge that may be more disruptive than people think.

“We’ve never have had QE like this before, we’ve never had unwinding like this before,” Dimon said at a conference in Paris Tuesday. “Obviously that should say something to you about the risk that might mean, because we’ve never lived with it before…. We act like we know exactly how it’s going to happen and we don’t.”

All the main buyers of sovereign debt over the last 10 years — financial institutions, central banks, foreign exchange managers — will become net sellers now, he said. (Newsmax)

A risk never experienced in the history of the world. Never is a long time. That risk, anticipated to begin at the end of summer, is far greater than the mere termination of QE that already took place or than the incremental rise in interest rates. This change actually sucks liquidity out of the market, versus slowing the expansion of liquidity.Considering the Fed has pumped $4.5 trillion of liquidity into the economy to help “recover” from the Great Recession, there is potentially a lot of unwinding to now begin, and it starts in an economy that is limping along the ground, not in the kind of recovery the Fed anticipated rewinding from. Between the European Central Bank, the Bank of the Japan and the Fed, there is $14 trillion to unwind … or, at least, some large portion of that.The Great Unwind happens in a period where global debt has reached $217 trillion, which presents a major problem for the Fed in selling off so many bonds. They will almost certainly have to offer them at better yields more interest in order to attract buyers. That sifts throughout debt markets to raise the interest on carrying or refinancing all of this debt. Nations will have to compete with central bank yields in order to issue new debt or refi old. The European Central Bank and Bank of Japan are also looking like they may start unwinding soon, so compound all of that in your mind.

“As I believe the main factor in driving market multiples to historically high levels was QE, ZIRP and NIRP, then yes, the reversal will have major implications for markets and volatility.” Peter Boockvar, chief market analyst at The Lindsey Group, told MarketWatch.

The Fed’s Great Unwind is scheduled to start (if the Fed’s hints bear out) during the stock market’s unwind from Trumphoria, too, and during the retail apocalypse and auto market crash:

Crispin Odey, who made money for a second straight month by sticking to bearish equity bets, said the chance of a market crash is rising as growth slows and the Federal Reserve normalizes interest rates.

The credit cycle boosted by loose monetary policy has peaked and there’s a widespread slowdown in the auto, commodity, industrial and retail sectors, Odey wrote in a letter to investors. Unlike previous dips since the financial crisis, central banks aren’t responding by printing more money.

“This time they are doing the reverse,” which is likely to exacerbate the negative trend, the London-based hedge fund manager wrote. “All this sits very uncomfortably with the fun being felt in the stock markets. When I look at the move up since Trump’s election as president, I detect the walk of a drunken man.”

“The chances of car crashes everywhere are rising,” according to Odey. “Enjoy the hot summer,” (Newsmax)

The timing for the Fed’s Great Unwind does not look fortuitous. Key to understanding why the Federal Reserve always has such bad timing so that it routinely crashes its own recoveries can be found in recognizing that the Fed’s dual mandate — setting monetary guidance based on maximizing jobs and maintaining inflation at a set level — means the Fed is always aiming to create goals that may take a year to develop from the time they make any change.Inflation is largely dependent on the wage/labor market, and a change in hiring decisions is dependent first on a change in economic conditions; so the movement of these lagging indicators that the Fed monitors the most can easily be a year or more away. Thus, the Fed will continue to move every quarter more and more toward their new bias of stimulus reduction until they see the results in their job and inflation metrics. But they are doing that when the economy is already receding. By the time they see the results in their two sacred metrics, they’ve moved further than they need to and downhill momentum has already built up.So, they will do it again.

The death of TrumphoriaThe irrational exuberance that superheated the stock market after Trump’s election is dead right where I said months ago it died. A quick look at any chart of its biometrics proves that:

The patient has been pretty-well flatlining for half a year with a couple of attempted jolts with the paddles that yielded no lasting results. The market has scratched its way sideways in daily tremors up and down ever since, but has gone almost nowhere for more than four months.While the NASDAQ just looks like a heart attack:

Chris Whalen, a long-time bank analyst, expects [bank] earnings to come in soft enough that the stocks will trade off. “There’s no real growth on the top line,” he told MarketWatch. After several lean years, banks have run out of expenses to cut to boost the bottom line.And most investors are finally starting to acknowledge that the hoped-for “reflation trade” isn’t coming, Whalen said. “The Trump Bump is dead.”

Hopes that the economy would be boosted by structural reforms, including tax reform, have faded as the administration of President Donald Trump has made little leeway on its plans. (Marketwatch)

The stock market gained a little more headroom in the first half of last month, but has, again, petered out. The market is in its summer doldrums — that hot, sultry period of dead winds before the summer storms — where any gains look like a mirage, typically passing away as soon as they are reached. Relentless stories about Trump’s supposed Russian electioneering collaboration — whether true or fake — also have diminished investor hopes that a fiscal stimulus plan will come about this year, an outcome I’ve suggested is likely all year.And FAANG stocks — those high-tech draft horses of the stock market — are now weighing down on the market with dead weight, rather than dragging it up. This is a major reversal of the pattern that has supported the market for years when many stocks were in a bear market, but the FAANG’s relentlessly pulled the averages ever skyward.Bank of America’s chief strategist Michael Harnett sees the top forming in the market and predicts the stock market will crash this fall:

We don’t think this is “big top” in stocks; greed harder to kill than fear; don’t think this “big top” in stocks…. summer 2017 = significant inflection point in central bank liquidity trade…will likely lead to “Humpty-Dumpty” big fall in market in autumn, in our view. But Big Top likely occurs when Peak Liquidity meets Peak Profits. We think that’s an autumn not summer story. (Zero Hedge)

In BofA’s view, the stagnant humidity we feel in the market now — the doldrums after Trumphoria — is building toward an autumn storm more likely than a summer storm because it will required the Fed’s move into the Great Unwind to really kick things off. I’ve said summer because I’d rather err’ on the side of safety, miss a part of the ride and be out ahead of the stampede. (And I’m not a trader, just someone who has moved his retirement funds out of stocks. I do not even try to give trading advice. My interest on this blog is macro-economics — where the economy is headed — and the stock markets of this world are only a part of that (a part we now know is rigged by central banks’ direct stock purchases).

Carmageddon on cruise control

“There’s been a consistent reduction in plant output in the last six months, and what is ahead in the next six months could be pretty startling,” said Ron Harbour, a noted manufacturing analyst….

“The industry has dramatically expanded employment in the United States in the last several years, but the growth is just not there anymore,” said Harley Shaiken, a labor professor at the University of California, Berkeley.

And companies are increasingly looking to build their less profitable car models outside the United States. Ford Motor, for example, said in June that it would move production of its Focus sedan to China from Michigan….

Scaling back jobs in car plants is part of a newfound discipline among automakers to avoid bloated payrolls and inventories when sales start slipping….

Moreover, the Detroit companies have also hired large numbers of lower-wage, entry-level employees with less costly unemployment benefits….

G.M., for example, has reduced the number of shifts at several of its domestic plants….“We are beginning to enter a period we call the post-peak,” said Jonathan Smoke, chief economist for Cox Automotive, which operates the auto-research sites Kelley Blue Book and Autotrader. (New York Times)

In summary:

The layoffs have begun. Last fall, Ford jolted the industry by revealing that its sales had peaked, while projecting a tough 2017. Then came the company’s April disclosure that it will need to slash $3 billion in costs to free up capital to invest in new technology. Soon after that came Ford’s announcement of as many as 20,000 layoffs worldwide, as well as word that GM had cut production at four U.S. assembly lines and would be laying off about 4,400 factory workers. Fiat Chrysler also laid off 1,300 workers at a Detroit assembly line.

By themselves, these announcements are not apocalyptic like the dire layoffs of 2008…. And yet, the present and future auto slow-down is a big deal because auto is critical to the manufacturing sector…. Focusing on just last year and the first quarter of this year, though, the data shows that auto represented fully 80 percent of U.S. manufacturing employment growth, even as auto hiring slowed significantly….

President Trump and congressional Republicans—along with regional economic development leaders from Kenosha to Wayne to Huntsville—should be worried about the direction of the auto and manufacturing sectors…. Auto industries won’t likely be able to carry the mantle of a manufacturing revival in the next year. (The Brookings Institute)

As part of that industry, auto parts are not doing any better than autos. O’Reilly Automotive Inc.’s disappointing sales slammed a sector already seen as Amazon’s next source of fodder, taking a record plunge as it missed its second-quarter projections. Advanced Auto Parts and AutoZone are also continued declining. O’Reilly shares plunged as much as 21%. It is another area where demand is shifting away from brick-and-mortar stores and toward online purchases. Some say that auto manufacturers, seeing that customers are hanging on to their old cars longer, are stiffening up competition from OEM parts, too.

Attempts to ward off the “retail apocalypse”Mitigating forces are at work, trying to turn the massive number of closures of mall anchor stores and smaller stores into opportunity for new life, but no one knows yet if these extravagant and creative efforts will work.

Costs are escalating as mall owners work to keep their real estate up to date and fill the void left by failing stores. The companies are turning to everything from restaurants and bars to mini-golf courses and rock-climbing gyms to draw in customers who appear more interested in being entertained during a trip to the mall than they are in buying clothes and electronics. The new tenants will pay higher rents than struggling chains such as Macy’s and Sears, and hopefully attract more traffic for retailers at the property, according to Haendel St. Juste, an analyst at Mizuho Securities USA LLC.

“The math is pretty obvious, pretty compelling, but there are risks,” St. Juste said in an interview. “This hasn’t been done before on a broad scale.”

…So far, jettisoning and replacing undesirable tenants has been a successful formula for many landlords, but there is still a lot of work to be done, according to Jeffrey Langbaum, an analyst with Bloomberg Intelligence. Some companies won’t have the cash to keep up amid the relentless pace of store closures, he said.

“For the most part, these companies have been able to redevelop and backfill space,” Langbaum said. “That’s great, but the big wave is still coming.”

…For Ziff of Time Equities, which buys outdated malls and renovates them, it doesn’t matter how you categorize the expenses of making over a center for the modern era, or if there is a linear path to a return on a particular project. Whether it’s installing a fireplace in a new food hall, or buying artwork for the common area, the aim is to drive higher traffic and tenant sales, he said. Ultimately, it’s all cash going out the door. (Newsmax)

The response teams to the retail crisis are already at work on makeovers, but the costs are high, and no one knows yet if it will work beyond a few well-positioned success stories. The fact that they are taking such major risks shows how significance this retail paradigm shift is.

Government bankruptcies continue to grow

I recently reported on the near-default situation of several states, showing how deeply to the core of the state the residual problems of the financial crisis cuts. You can add to that list of serious funding problems, the capital city of Connecticut:

Like many other local governments across the country, Hartford — city of Mark Twain and the young John Pierpont Morgan — has been grappling with budget problems for years. On the same day that Illinois lawmakers finally scrapped together a long-overdue budget, Hartford hired the law firm Greenberg Traurig LLP to evaluate its options, which include bankruptcy. It would be the first prominent U.S. municipality to seek protection from its creditors since Detroit did so in 2013. (Newsmax)

The rise in both corporate and national defaults right now is showing up in other areas of the world, too:

Sovereign government and corporate defaults in both developed and developing economies are beginning to emerge. For example, China has registered in 2017 its highest level of corporate defaults in the first quarter of a calendar year on record.

Delinquencies and charge-offs in the United States soared to $US1.4 billion in the first quarter of 2017, the highest recorded level since the first quarter of 2011….

In May 2017, six major Canadian banks were downgraded by Moody’s Investor Service (Moody’s) as concerns rise over soaring Canadian household debt and house prices leave lenders more vulnerable to losses. Moody’s also downgraded China’s sovereign debt in May 2017 for the first time since 1989 and has warned of further downgrades if further reforms are not enacted….

In May 2017, S&P has downgraded 23 small-to-medium Australian financial institutions as the risk of falling property prices increases and potential financial losses start to increase. In June 2017, Moody’s downgraded 12 Australian banks, including Australia’s four major Banks.

Standard and Poor’s and Moody’s downgraded bonds for the US State of Illinois down to one notch above junk bond status as the state has over $US 14.5b in unpaid bills. (Zero Hedge)

These pressures are spreading at a rate that could be considered endemic around the world by next year.

More storm clouds keep gatheringCredit demand for both credit cards and auto loans has gone deeply negative for the first time in years. Credit cards briefly touched into the negative in 2012 with a 4% decline; but this year’s decline of 11% far exceeds that. Auto loans haven’t gone negative since 2011, but are now seeing a 14% decline.US tax receipts have matched this negative move, also down about 14% this year with an uptick last month. They haven’t gone negative since the Great Recession, other than a brief downtick of about -4% in 2011. Other than that brief downtick, a negative turn of this indicator has exactly matched with every recession in the post WWII era.Factory orders took their second monthly drop and fell by more than economists expected. Durable goods orders declined in April and May, following a year of steady albeit slight growth.Even the formerly blind Fed Chair Alan Greenspan sees that we are now entering what he says will be a long, “very tough” period of stagflation. He anticipates GDP will bump up to growth of 3% for the second quarter, but says that is misleading number, “a false dawn,” that is merely born of problematic adjustments happening this quarter. “The presumption that we’re going to come bouncing back is utterly unrealistic.” (Newsmax) That’s quite a change for Greenspan who, like most central-bank chiefs, never saw trouble coming in the past.Bank of America Merrill Lynch’s “Sellside Indicator” hit its highest level since the official end of the Great Recession in June 2011. The indicator measures how bullish strategists are on US equities, now showing a strong move toward the “jump out and sell” side.The Chicago Fed National Economic Activity Index took its biggest drop since August, 2016.US mortgage applications and home purchases have seen steep declines recently. The week ending the month of June, usually a hot time for buying, dropped week-on-week by the most in half a year, even as interest rates had returned to nearly their lowest levels. Correspondingly, pending home sales fell each month from March through May. A majority of economists polled by Reuters, naturally, forecasted that May sales would increase. Here’s dirt in your eye, Economists.In summary, nothing happening this summer threatens my forecast from the beginning of the year, which said that a major economic breakdown would become evident by summer and that the stock market would crash sometime between early summer and the start of 2018, with it likely to be earlier than later. I’ve bet my blog on it, and I’ll comfortably stay with that bet. I don’t think the above confluence of forces proves that bet right, by any means; but clearly forces are continuing to build strongly in that direction. There is, in fact, almost nothing on our horizon in the US that looks like a playful summer on the beach. (I hope YOU have such a summer, but I am speaking in terms of the economy.)

The dollar and euro’s relative fortunes have transformed in 2017 as the greenback has declined and the European currency has risen. Photo: philippe huguen/Agence France-Presse/Getty Images

The pendulum has swung a long way in the foreign-exchange market. The dynamism of the dollar at the end of 2016 has given way to enthusiasm for the euro. That shift could yet support appetite for riskier assets such as emerging-market stocks and bonds.The WSJ Dollar Index has now unwound the boost it got from the election of Donald Trump in November, and is down about 6.5% this year. The greenback’s key counterpart, the euro, is up close to 10% in 2017. Early Tuesday, the euro rose above $1.15 for the first time since May 2016, reaching the top of the range it has been in since the start of 2015 under the influence of monetary-policy divergence between Europe and the U.S.The transformation in the dollar and euro’s relative fortunes in 2017 has been remarkable. The focus at the start of the year was on the U.S. Federal Reserve and its efforts to raise interest rates; now the European Central Bank has stolen the spotlight as it tacks gently away from ultraloose policy settings.Hopes for growth were centered on U.S. spending and tax reform under the Trump administration. Instead it is the eurozone that has delivered consistently positive surprises on growth. And it was Europe that was supposed to face political headaches. But it is the U.S. where the challenges are rising, with the collapse of the health-care bill just the latest example.True, a lot of these factors may now be in the euro-dollar exchange rate. Europe faces a higher bar to provide new positive surprises than the U.S. A further sharp rise in the euro might cause European policy makers to feel the currency is doing the tightening work on its own. Conversely, the risk might yet be that the Fed raises rates more than the market thinks is likely.But the ramifications of this shift are broad. A weaker dollar should add to the attraction of local-currency emerging-market assets. The Mexican peso, Brazilian real and South African rand have all risen against the dollar in July.The important thing for risk appetite is the reason for dollar weakness. As long as it reflects other parts of the world, such as the eurozone, faring better than expected relative to the U.S., rather than fears for the U.S. economy in particular, then emerging markets should have continued support. Seen like that, a weaker dollar is a source of strength.

It’s summertime and financial conditions are easy. So risk markets hardly flinched when the Federal Reserve said Wednesday it will begin to shrink its $4.4 trillion balance sheet “relatively soon.”

That would seem to mean Sept. 19-20, which is when the policy-setting Federal Open Market Committee is slated to meet again. That would be “relatively soon,” in Fedspeak, for the central bank to begin the process of reducing its holdings of Treasury and agency mortgage-backed securities, which it had amassed to pump liquidity into the financial system following the financial crisis.

Now that the 10th anniversary of the beginning of the crisis (which might be marked by the June 2007 failure of Bear Stearns’ hedge funds investing in toxic mortgage derivatives) has passed, the Fed is preparing to begin to withdraw the extraordinary measures taken to cope with the crisis.

To the surprise of no one, the FOMC left its federal funds rate target in a 1%-1.25% range. Market expectations of one more quarter-point hike by December were unchanged by the FOMC’s statement. Fed funds futures imply a 45% probability of such a move by year end, according to Bloomberg data.

As for the Fed’s main mandates, employment and price stability, those criteria were mixed. The FOMC statement noted “job gains have been sold, on average, since the beginning of the year, and the unemployment rate has declined.” At the same time, inflation is likely to remain below the Fed’s 2% target but the panel continues to expect it to stabilize around that level “over the medium term.”

As usual, there was no acknowledgement that the 4.4% jobless rate understates the slack in the labor market, as implied by the continued sluggish rate of wage gains of just over 2%. Or that its favored inflation measure, the so-called core personal consumption deflator, running at just 1.4%, doesn’t reflect the price pressures felt by most consumers.

Leaving aside the chasm between how the federal government and the average American view inflation, asset prices show incontrovertible signs of inflation. Undeterred by the FOMC’s plan to pare its balance sheet and thus drain some of the liquidity that has bolstered asset prices, the Standard & Poor’s 500, the Dow Jones Industrial Average and the Nasdaq Composite all ended at records Wednesday.

The corporate credit markets show the effect of ample liquidity even more directly. The spread on Baa-rated corporate bonds (the lowest investment grade) Tuesday shrank to just 2.18 percentage points, according to Evercore ISI. The narrower risk premium is associated with stronger economic growth, which the firm says is reflected in the company surveys and the robust showings in the current earnings-reporting season.

In what still is called the high-yield bond market, yields sank to record lows. The popular iShares iBoxx $ High Yield Corporate bond exchange-traded fund (ticker: HYG) closed just shy of its record price hit in the afternoon. More to the point, its “high yield” is a hair above 5%, which I can’t help but recall is less than what my grandmother’s passbook savings account used to pay. It’s also lower than what Treasury bills yielded prior to the financial crisis, which sent short-term interest rates to zero.

High stock and bond prices equate to easy financial conditions. As mentioned in my weekend column, the rallies in equities and credit produced the equivalent of a 1.25 percentage-point cut in the fed funds rate.

In the latest investment letter from Oaktree’s Howard Marks posted here Wednesday, the perspicacious veteran investor noted four key attributes of this easy environment. Asset prices are high; many investors have taken on risk to reach their returns goals; at the same time, prospective returns are about as low as they’ve ever been. Finally, uncertainties are unusually high, notably for future growth, interest rates and inflation, political dysfunction and the long-term impact of technology.

As for risk, the CBOE Volatility Index, or VIX, is at the lowest level in its 27-year history. The last time the so-called fear gauge was this low was “when Bill Clinton took office in 1993, at a time when there was peace in the world, faster economic growth and a much smaller deficit.” Should investors be equally confident or complacent now?

Fed Chair Janet Yellen says the process of unwinding the central bank’s balance sheet should be as boring as “watching paint dry.” Given the current backdrop of lofty valuations and heightened uncertainty, the unprecedented process of reducing the Fed’s massive holdings could prove to be interesting times, as in the Chinese curse.

LONDON – As the Nobel laureate economist Robert Solow noted in 1987, computers are “everywhere but in the productivity statistics.” Since then, the so-called productivity paradox has become ever more striking. Automation has eliminated many jobs. Robots and artificial intelligence now seem to promise (or threaten) yet more radical change. Yet productivity growth has slowed across the advanced economies; in Britain, labor is no more productive today than it was in 2007.

We start with 100 farmers producing 100 units of food: technological progress enables 50 to produce the same amount, and the other 50 to move to factories that produce washing machines or cars or whatever. Overall productivity doubles, and can double again, as both agriculture and manufacturing become still more productive, with some workers then shifting to restaurants or health-care services. We assume an endlessly repeatable process.

But two other developments are possible. Suppose the more productive farmers have no desire for washing machines or cars, but instead employ the 50 surplus workers either as low-paid domestic servants or higher-paid artists, providing face-to-face and difficult-to-automate services. Then, as the late William Baumol, a professor at Princeton University, argued in 1966, overall productivity growth will slowly decline to zero, even if productivity growth within agriculture never slows.

Or suppose that 25 of the surplus farmers become criminals, and the other 25 police. Then the benefit to human welfare is nil, even though measured productivity rises if public services are valued, as per standard convention, at input cost.

The growth of difficult-to-automate service activities may explain some of the productivity slowdown. Britain’s flat productivity reflects a combination of rapid automation in some sectors and rapid growth of low-productivity, low-wage jobs – such as Deliveroo drivers riding around on plain old-fashioned bicycles. In the United States, the Bureau of Labor Statistics reports that eight of the ten fastest-growing job categories are low-wage services such as personal care and home health aides.

The growth of “zero-sum” activities may, however, be even more important. Look around the economy, and it’s striking how much high-talent manpower is devoted to activities that cannot possibly increase human welfare, but entail competition for the available economic pie. Such activities have become ubiquitous: legal services, policing, and prisons; cybercrime and the army of experts defending organizations against it; financial regulators trying to stop mis-selling and the growing ranks of compliance officers employed in response; the huge resources devoted to US election campaigns; real-estate services that facilitate the exchange of already-existing assets; and much financial trading.

Much design, branding, and advertising activity is also essentially zero-sum. It is certainly good that new fashions can continually compete for our attention; choice and human creativity are valuable per se. But we have no reason to believe that 2050’s designs and brands will make us any happier than those of 2017.

Such zero-sum activities have always been significant. But they grow in importance as we approach satiation in many basic goods and services. In the US, “financial and business services” now account for 18% of employment, up from 13.2% in 1992.

The impact on measured GDP and productivity reflects national accounting conventions. If people devote more of their income to competing for scarce housing, driving up property prices and rents, GDP and “productivity” increase, because housing rent is included in GDP, even if the aggregate supply of housing services is unchanged. Since 1985, the share of rents in the UK economy has doubled, from 6% of GDP to 12%.

Likewise, more and better-paid divorce lawyers increase GDP, because end consumers pay them. But more and better-paid commercial lawyers don’t raise output, because companies’ legal expenditures are an intermediate cost. Measured productivity slows as intermediate zero-sum activities proliferate, while other zero-sum activities swell GDP but deliver no welfare benefit.

Potentially offsetting this effect, information technology may improve human welfare in ways not captured in measured output. Billions of hours of consumer time previously spent filling in forms, making telephone calls, and queuing are eliminated by Internet-based shopping and search services. Valuable information and entertainment services are provided for free.

Contrary to what some right-wing economists argue, such free services cannot make increasing income inequality irrelevant. If rents and commuting costs are driven up by intense competition for attractively located property, you can’t pay for them out of freely arising “consumer surplus.” But the essential insight is still important: much that delivers human welfare benefits is not reflected in GDP.

Indeed, measured GDP and gains in human welfare eventually may become entirely divorced. Imagine in 2100 a world in which solar-powered robots, manufactured by robots and controlled by artificial intelligence systems, deliver most of the goods and services that support human welfare. All that activity would account for a trivial proportion of measured GDP, simply because it would be so cheap.

Conversely, almost all measured GDP would reflect zero-sum and/or impossible-to-automate activities – housing rents, sports prizes, artistic performance fees, brand royalties, and administrative, legal, and political system costs. Measured productivity growth would be close to nil, but also irrelevant to improvement in human welfare.

We are far from there yet. But the trend in that direction may well help explain the recent productivity slowdown. The computers are not in the productivity statistics precisely because they are so powerful.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.